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How commodities trade: Venues and benchmarks: where the world's prices are made

Understanding Commodities / Module 6: How commodities trade Part 2 of 5

Venues and benchmarks: where the world's prices are made

A handful of exchanges and price publishers set the reference prices for most physical trade. Some are a century and a half old; the busiest are now in Asia. Where no futures market works, a price reporting agency surveys deals and publishes an assessment. This part explains why some commodities get exchanges and others do not, and who makes the numbers that contracts point to.

2.1 Futures markets succeed only under certain conditions, then tend to win outright

Radetzki and Wårell list five conditions for a working futures market. There must be many buyers and sellers. Physical traders must be willing to hedge, with speculators to take the other side. Prices must vary enough to make hedging worth paying for. The commodity must be easy to grade, so the contract can say what is delivered. And it must be storable, so spot and futures prices are linked.

The list keeps lengthening: gold in 1975, nickel and aluminium in 1979, crude oil in 1983, steel in 2006, cobalt, molybdenum and palm oil in 2010, coking coal and iron ore in 2013. The holdouts fail one of the tests. Tea and ferrochrome are hard to grade. Niobium's supply is so concentrated that one producer can set prices. US stockpiles and price supports kept groundnuts and tobacco off exchanges by removing the need to hedge.

Once a contract works, it tends to take the whole market. Pirrong explains the feedback: the more people trade a contract, the cheaper it is to trade, which draws more trading. Activity usually tips to one contract per commodity; oil, with Brent and WTI side by side, is the exception.

Exchange prices also displace other quotes. After aluminium joined the LME in 1979, its price became the accepted reference during the 1980s and producer list prices faded. Steel futures on the LME replaced trader quotes, and OPEC stopped posting prices after crude futures appeared.

  • Radetzki & Wårell (2021), A Handbook of Primary Commodities in the Global Economy · pdf pp. 147-148, 154-156
  • Pirrong (2014), The Economics of Commodity Trading Firms · pdf p. 13

2.2 London, Chicago and New York built the benchmarks

The London Metal Exchange, founded in 1877, trades aluminium, copper, lead, nickel, tin and zinc. Its official prices are set in five-minute open-outcry sessions in the ring, and Humphreys reports that they serve as reference prices for metal and ores traded worldwide. Its turnover is typically around 40 times annual metal production: most of it is paper, and that paper is what makes the price reliable and hedging cheap.

Chicago is the home of grain futures. The Chicago Board of Trade opened in 1848 and wheat, which Geman calls the oldest commodity contract, traded there from around 1850. Geman lists corn, soybeans and wheat, in that order, as its most traded contracts; the CBOT is now part of the CME Group.

New York's NYMEX began in 1872 as the Butter and Cheese Exchange. Yergin and Blas and Farchy tell how a default on Maine potato futures in 1976 nearly destroyed it, so it tried petroleum: heating oil, then gasoline, and on 30 March 1983 crude oil, for West Texas Intermediate delivered at Cushing, Oklahoma. An oil executive called it a way for dentists to lose money; within a few years most of the majors were trading it. COMEX, merged into NYMEX in 1994, launched the gold contract that became the world reference in 1974.

London's other pillar is ICE. The International Petroleum Exchange was founded in 1980 and launched Brent futures in June 1988. ICE, fully electronic from its start in 2000, bought exchanges until it ranked fourth in the world. In 2018 the CME Group alone handled 4.8 billion futures and options contracts, 16% of the world total.

  • Humphreys (2015), The Remaking of the Mining Industry · pdf pp. 101-102
  • Geman (2005), Commodities and Commodity Derivatives · pdf pp. 21-23, 161, 183
  • Yergin (1991), The Prize · pdf pp. 1247-1250
  • Blas & Farchy (2021), The World for Sale · pdf pp. 101-102
  • Radetzki & Wårell (2021), A Handbook of Primary Commodities in the Global Economy · pdf pp. 143-147

2.3 Asia now trades more contracts than anywhere else

Radetzki and Wårell show how fast the centre of gravity has moved east. In the first half of 2019 more than 40% of all futures and options contracts traded worldwide were traded in the Asia-Pacific region. In 2018 the five most traded metals contracts in the world were on the Shanghai Futures Exchange and the Dalian Commodity Exchange, and among metals and minerals the top three futures were steel, iron ore and nickel.

China has three commodity exchanges, each with a specialism. The Shanghai Futures Exchange trades base metals, steel and energy; in 2018 its steel contract alone traded 531 million times. The Dalian Commodity Exchange trades soybeans, meal, oil, palm olein and iron ore, the last in 100-tonne lots. The Zhengzhou Commodity Exchange trades cotton, rapeseed meal and other farm goods. Their contracts are small, often 10 tonnes, so contract counts overstate tonnage compared with London.

India's National Stock Exchange ranked second in the world in 2018 with 3.8 billion contracts, mostly financial. Commodity trading runs mainly through specialist exchanges: MCX lists bullion, energy, base metals such as copper, zinc and aluminium, and cotton, while NCDEX concentrates on farm goods. In December 2021 the regulator, SEBI, suspended trading in seven farm contracts, including wheat, chana (chickpea), mustard seed and soybean, and it has extended the ban every year since, most recently to March 2027.

In the tiles, copper is quoted on the LME, COMEX and Shanghai, with MCX for India. iron ore swaps trade in Singapore and futures in Dalian, and cotton trades on ICE in New York, Zhengzhou and MCX.

2.4 Price reporting agencies assess prices where no exchange quote exists

Where commodities are too varied for a futures contract, price reporting agencies supply the price that contracts point to. Platts has tracked oil deals since the 1930s; Geman notes that despite competition from Argus it effectively sets oil prices rather than merely reporting them. Metal Bulletin, now Fastmarkets, does the same for metals and ores. Tilton and Guzmán describe the method: confidential surveys of bids, offers and deals, turned into an assessed price for a defined grade, place and timing.

Geman walks through dated Brent. Platts records deals for cargoes loading 10 to 21 days ahead. If the only spot deal on a day is struck at January Brent futures minus $0.20 and the futures settle at $49.80, the assessment is $49.60. Other crudes are then priced as differentials to that benchmark: a cargo of Urals might sell at dated Brent minus $1.50. Over half of internationally traded crude is priced off Brent in this way. Forwards, contracts for difference, futures and swaps are layered on top, so a thin physical market anchors a vast paper market.

Iron ore shows an assessment replacing a negotiation. For decades the first annual settlement between a big miner and a steelmaker set everyone's price. Humphreys traces its collapse: spot cargoes rose from 15% of seaborne trade in 2001 to almost 40% in 2008, sold by small Chinese and Indian mines far above contract. When spot fell below contract after 2008, some buyers walked away. By 2010 pricing had moved to quarterly, then shorter, terms based on daily assessments by Platts, Metal Bulletin and The Steel Index for 62% iron ore delivered to China, with swaps on the Singapore Exchange.

  • Geman (2005), Commodities and Commodity Derivatives · pdf pp. 218-223, 231-232
  • Humphreys (2015), The Remaking of the Mining Industry · pdf pp. 122-126
  • Tilton & Guzmán (2016), Mineral Economics and Policy · pdf p. 97
  • Radetzki & Wårell (2021), A Handbook of Primary Commodities in the Global Economy · pdf pp. 119-120, 124

See it in the table

Oil Crude oilKc Coking coalCu CopperAl AluminiumZn ZincNi NickelFe Iron oreSt SteelMo MolybdenumNb NiobiumAu GoldCo CobaltWh WheatSoy Soybeans

Check your understanding

Why have tea and ferrochrome lacked successful futures contracts?

A futures contract must specify exactly what is delivered. Where quality varies too much, no single contract can serve hedgers.

On a given day the only dated Brent deal is done at January futures minus $0.20, and January futures settle at $49.80. What does Platts publish?

Geman's example: the agency applies the traded differential to the futures settlement. Other crudes are then priced as differentials to this assessment.

What mainly ended annual benchmark pricing for seaborne iron ore?

Humphreys shows the spot share rising from 15% to almost 40% of seaborne trade by 2008. When spot dropped below contract after 2008, producers realised the benchmark had given buyers a free option.
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